- The income that one can earn doing a job is a fairly good starting point in estimating its social value, because it generally factors in most of the relevant considerations that go into estimating the social value.
- There are a few systematic factors that weaken the relationship between income and social value. These are discussed below.
- It is very hard to come up with a robust way of weighing these additional considerations.
Why income is a good proxy
A deeper understanding of why this is generally expected to be the case requires an understanding of basic economics. You might wish to check out our economics reading recommendations. A brief summary is that money is the currency through which people keep track of value. Changes to value that are related to economic transactions are reflected in the associated prices.
The rough argument: income as a measure of value experienced by customers
The reason essentially connects to why, in a (largely) free market, one's income represents how much people are willing to pay for one's services, and this is a measure of the value these services provide to those other people. If one produces a product that someone else finds very valuable, that person will tend to be willing to pay a lot for it. If one produces a large quantity of a product that's purchased by many people, the total amount that the customers pay will be large.
Income takes flow-through effects into account
One can produce value (positive or negative) not only for one's customers but also for their customers, and their customers' customers, and so on. These effects are sometimes called flow-through effects. Income takes flow-through effects into account as follows: If your customers' customers derive more value, they are willing to pay your customer more. The promise of being able to make more money increases the value of your service to your customer, so you can charge your customer more.
Further, income quantitatively reflects each of the criteria that determine the magnitude of flow-through effects:
- Subjective value criterion: Greater subjective value correlates with greater income as well as greater flow-through effects.
- Productivity enhancement criterion: People are generally willing to pay more for tools that enhance their productivity as opposed to leisure goods, though this is not uniformly the case. Productivity-enhancing value creation also correlates with higher flow-through effects.
- Value created by customers criterion: The greater the value your customers create for their customers, the greater both the income they are willing to pay (for the same improvement in their productivity or subjective experience) and the greater the flow-through effects (for instance, compare providing a high-productivity person and a low-productivity person Internet access, even if they both enjoy it equally).
Income takes replacability into account
Some jobs have the property that it's very important that somebody do them, but that it's relatively easy to find people to do them. (Nowadays, food production is an example.) If you take such a job, you will contribute much less social value than you would if nobody else could do the job, because if you don't do it, somebody else will. Income partially takes this into account in the following ways:
- Customers tend to pay the lowest price possible, so if multiple suppliers are available, no supplier can charge more than the smallest price at which the other suppliers would be willing to provide the good.
- Income also accounts for what your counterfactual replacement might earn in another job. If the person who would replace you in a given job A could generate high value in another job B, then that is an argument in favor of your doing the job A (so your counterfactual replacement is freed up to do job B). Income takes this dynamic into account: because your replacement has another high-value job B, that bids up his/her asking price for A, and therefore raises the average income for A, making A more attractive to you.
Ways in which income can be a bad proxy
General problems with any economic proxy
Irrationality, imperfect information, systems being away from equilibrium, and many other general flaws with the functioning of markets make economic proxies in general somewhat unreliable.
In some cases, your work may significantly affect other people who are not your customers and do not have contractual relationships with you. The classic example of negative externalities (your work harms others) is the polluting factory that makes the air and water unclean, increasing the incidence of various diseases in the population of the nearby town. An example of positive externalities may be: you paint the front yard of a home, and the neighbors experience aesthetic delight.
The existence of negative externalities is not a decisive argument against doing something, and similarly, the existence of positive externalities is not a decisive argument for doing something. Externalities are important because they point to a possible source of disconnect between income and social value.
Distinction between externalities and flow-through effects
Externalities need to be distinguished from a more general concept of flow-through effects. Flow-through effects refers to the fact that people who are not your direct customers benefit from your service, perhaps as customers of your customers. For instance, you may provide technical support to a supermarket, which in turn is better able to serve its customers. Such flow-through effects, that proceed through a chain of market relationships, are not examples of externalities, and the price mechanism should work as a reasonable proxy, at least in principle (subject to the general problems that all economic proxies face).
A person providing a service to people with little wealth may not be able to make much money even though the customers gain a lot, because of their limited ability to pay. A person providing a similar service to wealthy people may make much more money.
However, it should be noted that providing the same service to wealthier people can generate more social value than providing the service to poor people, due to flow-through effects. A wealthy person and a poor person may experience the same consumption benefit from Internet access, but the wealthy person is (on average) more likely to be able to productively use the Internet access to create social value. Thus, the measurement distortion created by wealth effects is not as huge as it might seem at first glance.
Markets can be distorted, typically by governments, but sometimes also by non-governmental agencies that exert huge power. Examples include:
- Credentialism: Artificially restricting the pool of people who can perform a job to those who acquire certain credentials (even though the credentials are not needed for doing the job) might restrict supply, drive up wages, and also drive up the costs of getting the credentials.
- Subsidies and taxes: Subsidies to certain industries can distort the price mechanism. For instance, if the government subsidizes purchases of a certain good (education, housing, food) then incomes for people supplying that good can rise out of proportion with the value they generate. Arguably, the government subsidy is an attempted corrective for other problems that cause the service providers to be undercompensated for the social value they generate (such as externalities and wealth effects). However, this may not always be the case in practice.